class: center, middle, inverse, title-slide .title[ # Principles of Microeconomics ] .author[ ### ECO 2306 ] .date[ ### <em>Fall 2022</em> ] --- class: center, middle, inverse # Chapter 3: Where Prices Come From: The Interaction of Demand and Supply --- ## Market Organization - Three fundamental questions every economy must answer 1. What will we make? 2. How will we make it? 3. How will we get it to buyers? -- - Market economies - Rely on how well free market organizes the economic activity to answer these questions - Rely on interaction of supply and demand -- - *Simplified* supply/demand model - Assume perfect competition - **Perfectly competitive market**, a market with - many buyers and sellers, - all firms selling identical products, and - no barriers to new firms entering the market - Gives some insight into how markets work in the real world --- ## Market Demand: how do buyers behave? .panelset[ .panel[.panel-name[Overview] - **Market demand**: the demand by all the consumers of a given good or service - Analyze where prices come from by investigating how buyers behave - Study the relationship between *quantity* and *price* via tables and graphs - **Demand schedule**: a table showing the relationship between price and quantity of product demanded - **Demand curve**: a curve showing the relationship between price and quantity of product demanded <img src="data:image/png;base64,#images/fig_3_1.png" width="65%" style="display: block; margin: auto;" /> ] .panel[.panel-name[Definitions] - **Quantity demanded**: the amount of a good/service that someone is willing and able to buy at a particular price - Primary assumption: **Ceteris paribus** condition - "All else equal" - The requirement that when analyzing the relationship between two variables—such as price and quantity demanded, other variables must be held constant - **Law of demand**: A rule that states that, holding everything else constant, - when the price of a product falls, the quantity demanded of the product will increase, and - when the price of a product rises, the quantity demanded of the product will decrease <img src="data:image/png;base64,#images/fig_3_1.png" width="50%" style="display: block; margin: auto;" /> ] .panel[.panel-name[Slope] - Why does demand slope downward? - Substitution effect: - The change in the quantity demanded of a good that results from a price change making the good more or less expensive relative to substitutes - Higher prices make other goods relatively less expensive - Income effect: - the change in the quantity demanded of a good that results from the effect of price change on consumers' purchasing power - Higher prices make people poorer <img src="data:image/png;base64,#images/fig_3_1.png" width="50%" style="display: block; margin: auto;" /> ] ] ] --- ## Shifting Market Demand .panelset[ .panel[.panel-name[Shifts] .left-column[ <img src="data:image/png;base64,#images/fig_3_2.png" width="100%" style="display: block; margin: auto;" /> s  ] .right-column[ - A change in something other than price that affects demand causes the entire demand curve to shift. - A shift to the right `\((D_1 \text{ to } D_2)\)` is an **increase in demand** - A shift to the left `\((D_1 \text{ to } D_3)\)` is a **decrease in demand** - Quantity demanded - As the demand curve shifts, the quantity demanded will change, even if the price doesn’t change. - The quantity demanded changes at every possible price. ] ] .panel[.panel-name[Factors] .center[  ] ] .panel[.panel-name[Income] ### Income - **Normal good**: - demand increases as income rises and decreases as income falls - e.g.: new clothes, restaurant meals, vacations - **Inferior good**: - demand decreases as income rises and increases as income falls - e.g.: second-hand clothes, instant ramen - If you get a raise this month, what happens to your demand for - new clothes? - used clothes? ] .panel[.panel-name[Related goods] ### Prices of related goods - Substitutes: - Goods and services that can be used for the same purpose - e.g.: Big Mac and Whopper, F-150 and Silverado, Jeans and Khakis - Complements: - Goods and services that are used together - e.g.: Big Mac and McDonald’s fries, hot dogs and hot dog buns, left shoes and right shoes - If price of Big Mac goes up, what happens - to demand for Whoppers? - to demand for McDonald's fries? ] .panel[.panel-name[Preferences] ### Tastes or preferences - If consumers’ tastes change, they may buy more or less of the product. - Examples: - If consumers become more concerned about eating healthy, they might decrease their demand for fast food. - An Samsung advertising campaign effective and all the cool kids want a Samsung phone--what happens to the demand for iPhones?  ] .panel[.panel-name[Population] ### Changes in population .pull-left[ - Demographics: The characteristics of a population with respect to age, race, and gender. - Increases in the number of people buying something will increase the amount demanded. - Example: An increase in the elderly population increases the demand for medical care. ] .pull-right[  ] ] .panel[.panel-name[Expectations] ### Changes in expectations about the future - Consumers decide which products to buy and also when to buy them. - Future products are substitutes for current products. - An expected increase in the price tomorrow increases demand today. - An expected decrease in the price tomorrow decreases demand today. - Examples - If the price of housing is going down in the future, your demand today may shift down - If you found out the price of gasoline would go up tomorrow, you would increase your demand today ] ] --- ## Application of Demand Factors ### Natural Disasters - What factors shift demand when hurricanes are projected to hit cities in Texas? - Grocery stores - Hardware stores .center[  ] --- ## Demand vs. Quantity Demanded .left-column[   ] .right-column[ - A change in the price of the product being examined - Move along the demand curve - This is a change in **quantity demanded**. - Any other change affecting demand - Entire demand curve shifts - This is a change in **demand** ] --- ## Market Supply .panelset[ .panel[.panel-name[Overview] - There are some similarities, and some important differences, between the demand and supply sides of the market. - In this section, we examine the **market supply**, i.e., the decisions of (generally) firms about how much of a product to provide at various prices. - **Supply schedule**: A table that shows the relationship between the price of a product and the quantity of the product supplied. - **Supply curve**: A curve that shows the relationship between the price of a product and the quantity of the product supplied. <img src="data:image/png;base64,#images/fig_3_4.png" width="50%" style="display: block; margin: auto;" /> ] .panel[.panel-name[Definitions] - **Quantity supplied**: The amount of a good or service that a firm is willing and able to supply at a given price. - Primary assumption: **Ceteris paribus** condition - "All else equal" - The requirement that when analyzing the relationship between two variables—such as price and quantity demanded, other variables must be held constant - **Law of supply**: A rule that states that, holding everything else constant, - increases in price cause increases in the quantity supplied, and - decreases in price cause decreases in the quantity supplied <img src="data:image/png;base64,#images/fig_3_4.png" width="50%" style="display: block; margin: auto;" /> ] .panel[.panel-name[Slope] - Why do supply curves slope upwards? - the supply curve represents the *marginal cost of production* - higher prices are necessary to induce production by the higher opportunity cost units - Application: - You can pay a kid $20 to mow your lawn - But you may have to double that price to get professionals to do it ] ] --- ## Shifting Market Supply .panelset.sideways[ .panel[.panel-name[Shifts] .pull-left[ <img src="data:image/png;base64,#images/fig_3_5.png" width="100%" style="display: block; margin: auto;" /> ] .pull-right[  ] ] .panel[.panel-name[Factors] <img src="data:image/png;base64,#images/factors_of_supply.png" width="100%" style="display: block; margin: auto;" /> ] .panel[.panel-name[Inputs] ### Changes in production input prices - Inputs - anything used in the production of a good or service - E.g.: for an athletic shoe, inputs include the rubber, plastic, and labor - The supply curve represents the marginal cost of production, - so anything that effects the marginal cost directly will shift the supply curve - input prices are the factor most responsible for shifting the supply curve - An increase in the price of an input - decreases the profitability of selling the good, - causing a decrease in supply - A decrease in the price of an input - increases the profitability of selling the good, - causing an increase in supply ] .panel[.panel-name[Related goods] ### Prices of related goods - **Substitutes in production** - Many firms can produce and sell alternative products - Example - An Illinois farmer can plant either corn or soybeans - If the price of soybeans rises, that farmer will plant (supply) less corn - **Complements in production** - Sometimes, two products are necessarily produced together - Example - Cattle provide both beef and leather - An increase in the price of beef encourages more cattle farming, which increases the supply of leather ] .panel[.panel-name[Technology] ### Changes in technology -A firm may experience a positive or negative change in its ability to produce a given level of output with a given quantity of inputs. - We call this a **technological change** - Typically shifts the supply curve rightward as now the firm can produce more with the same number of inputs - Examples: - A new, more efficient way of producing shoes would increase their supply. - Governmental restrictions on how much workers are allowed to work might decrease the supply of athletic shoes. ] .panel[.panel-name[Number of firms] ### Changes in number of firms - More firms in the market will result in more product available at a given price (greater supply). - Fewer firms `\(\rightarrow\)` supply decreases - Self-explanatory ] .panel[.panel-name[Expectations] ### Changes in expectations about future prices If a firm anticipates that the price of its product will be higher in the future, it might decrease its supply today in order to increase it in the future Example - if the price of oil is expected to rise in the future, - then an oil producer will leave it in the ground today, why? - so that they can sell it tomorrow at the higher price ] .panel[.panel-name[Quantity supplied] ### Market Supply vs. Quantity Supplied .pull-left[ - **Quantity supplied** - A change in the price of the product being examined causes a movement along the supply curve. - This is a change in quantity supplied. - **Market supply** - Any other change affecting supply causes the entire supply curve to shift. - This is a change in supply. ] .pull-right[  ] ] ] --- ## Market Equilibrium .panelset.sideways[ .panel[.panel-name[Overview] - The purpose of markets is to bring buyers and sellers together - The supply and demand model is a model about how prices adjust until there's no surplus or shortage of goods demanded and supplied - That adjustment happens by a kind of natural bidding up or down of the price until the shortages/surpluses vanish and supply equals demand - **Market equilibrium** is a situation in which quantity demanded equals quantity supplied. - Recall that markets with many buyers and sellers are perfectly competitive markets; - a market equilibrium in one of these markets is called a **competitive market equilibrium** ] .panel[.panel-name[Equilibrium]  ] .panel[.panel-name[Surpluses/shortages]  ] .panel[.panel-name[Interaction] - Demand and supply both count - Price is determined by the interaction of buyers and sellers. - Neither group can dictate price in a competitive market (i.e. one with many buyers and sellers). - However, changes in supply and/or demand will affect the price and quantity traded. - Predictions about price and quantity in our model require us to know demand and supply curves. - Typically, we know price and quantity but do not know the curves that generate them. - The power of the demand and supply model is in its ability to predict *directional* changes in price and quantity ] .panel[.panel-name[Demand Increase]  ] .panel[.panel-name[Supply Increase]  ] .panel[.panel-name[Demand and Supply Increase]  ] .panel[.panel-name[Demand shift more than supply]  ] .panel[.panel-name[Supply shift more than demand]  ] ] --- ## Equations .panelset[ .panel[.panel-name[Linear functions] .pull-left[ Supply and demand curves can also be represented with functions We'll focus on simple linear functions to make the math easy - Supply: `\(P = 2Q\)` - Demand: `\(P = 75-Q\)` ] .pull-right[  ] ] .panel[.panel-name[Equilibrium] .pull-left[ <!-- - A picture is worth a thousand equations --> <!-- - Just set each equation equal to P, and then set the right-hand-side of both --> <!-- equations equal to one another --> $$ `\begin{aligned} Supply &= Demand\\ 2Q &= 75 - Q\\ 2Q + Q &= 75 - Q + Q\\ 3Q &= 75\\ Q &= 25 \end{aligned}` $$ <!-- - Once you know the equilibrium quantity (Q) plug it into either equation to find equilibrium price --> $$ `\begin{aligned} Demand \rightarrow P^* &= 75 - Q^*\\ P^* &= 50\\ Supply \rightarrow P^* &= 2Q^*\\ P^* &= 50 \end{aligned}` $$ ] .pull-right[  ] ] ] --- ## Examples <table class="table table-striped table-hover table-condensed" style="font-size: 18px; float: right; margin-left: 10px;"> <thead> <tr> <th style="text-align:left;"> Price </th> <th style="text-align:right;"> Qty_Supplied </th> <th style="text-align:right;"> Qty_Demanded </th> </tr> </thead> <tbody> <tr> <td style="text-align:left;"> $1.50 </td> <td style="text-align:right;"> 0 </td> <td style="text-align:right;"> 95000 </td> </tr> <tr> <td style="text-align:left;"> $1.75 </td> <td style="text-align:right;"> 10000 </td> <td style="text-align:right;"> 85000 </td> </tr> <tr> <td style="text-align:left;"> $2.25 </td> <td style="text-align:right;"> 20000 </td> <td style="text-align:right;"> 75000 </td> </tr> <tr> <td style="text-align:left;"> $3.00 </td> <td style="text-align:right;"> 30000 </td> <td style="text-align:right;"> 55000 </td> </tr> <tr> <td style="text-align:left;"> $4.00 </td> <td style="text-align:right;"> 45000 </td> <td style="text-align:right;"> 45000 </td> </tr> <tr> <td style="text-align:left;"> $5.00 </td> <td style="text-align:right;"> 50000 </td> <td style="text-align:right;"> 35000 </td> </tr> </tbody> </table> - At a price of $3.00, - the quantity supplied is what? - the quantity demanded is what? - is this a surplus or shortage, why? -- - Find the equilibrium price and quantity. -- - Now suppose 25,000 people suddenly move away. - Find the new equilibrium price and quantity. --- ## Examples - Suppose Bubba Gump's shrimp company faces the following demand and supply equations: - `\(P = 50 - 2Q^D\)` - `\(P = 35 + Q^S\)` - What is the equilibrium price and quantity for Bubba Gump's shrimp? - Equations - Graphically ---